Small Business Working Capital Guide

As a business owner, it’s extremely important to understand how much working capital you have on hand. Why? There’s the obvious answer of having enough cash on hand to pay your bills, but there a few more layers to consider.

  • Are you looking for a business loan?
  • Are you thinking about selling your company?
  • What is the overall health of your small business?
  • Do you need a new piece of equipment?
  • Can you make payroll?
  • Can I expand?

To find out how much working capital you have, you need to open your Balance Sheet and look at your Current Assets & Current Liabilities. The formula to determine how much working capital your small business has is:

Current Assets – Current Liabilities = Working Capital

What are Current Assets?

Current Assets are assets that are considered liquid in a time period of 12 months or less. In other words, these are the items that can be converted into cash easily and quickly. They are listed in the order of liquidity meaning what money do you have access to the fastest. Here are your current assets listed in order of most liquid to least:

  1. Cash. This is the amount of cash presently available in your bank account(s). In a previous post about managing your businesses’ cash flow, we mentioned how important it is to keep up to date with your bookkeeping. Looking at the cash line item on your balance sheet is only useful if that number is kept as up to date as possible. If not, this would render the working capital formula to be useless.
  2. Accounts Receivable. These are monies owed to you whether they are aged receivables or future receivables. This is another report in your bookkeeping records that is applicable if you collect payment on credit terms like net 30. It’s an easy to read snapshot of who presently owes you money, who is past due on their invoice, and when you should expect future payments from customers.
  3. Inventory. This line item pertains to retailers, distributors, and manufacturers. It measures, in dollars, the period between which goods are purchased and sold. Inventory for retailers and distributors would be merchandise whereas manufacturers will have raw materials, work-in-progress, finished goods, and shipping supplies. Manufacturers are required to list their inventory on their balance sheet by those categories.

What are Current Liabilities?

Current Liabilities are debt obligations that will need to be paid in a period of 12 months or less. These are listed in the order of which liabilities are due the quickest. Here are your current liabilities listed by most recent due date:

  1. Accrued Expenses. Accrued expenses are goods and services your business has received, but that you have not been invoiced for yet. Examples include salary and bonuses incurred but not due yet, interest accruing on a loan, and taxes. These are expenses that your business is aware of, but no invoice has been received and therefore no payment has been recorded.
  2. Accounts Payable. These are items in which an invoice has been received, but a payment has yet to be recorded because it may not be due yet. For example you receive an invoice from your landlord on the 25th of the month which you enter into Accounts payable however the due date isn’t until the 1st of the following month.

Again, keeping your bookkeeping up to date helps to keep your business in good financial health.

Working Capital

Are you in a healthy working capital position or not?

  1. Negative Working Capital. This is when your current liabilities are larger than your current assets. Hopefully if your business encounters this scenario its temporary and not a long term issue. If your small business is stuck in a negative cash flow position, we have resources available to support you.
  2. Positive Working Capital. This is when your current assets are larger than your current liabilities. A good working capital position is subjective, but a comfortable working capital position is a value that is 2 to 3 times the number of your average monthly expenses.

Improve your small businesses’ negative working capital position by knowing your financials. It helps you pinpoint areas of opportunity to improve your working capital position. For example, look at your accounts receivable. Are you customers always paying late? If so, look for ways to improve your invoicing and collection system with frequent reminders and giving customers different options for payment. In some cases, using short term working capital loans to build cash, accounts receivable, or inventory. Business loans can also help you clean up your balance sheet by paying down current liabilities if cash is tight.

Positive working capital gives you leverage to grow and invest back into your business. Keeping working capital in the positive gives you better terms on business loans, more growth opportunities, and a chance to improve your goods and services.